OTC markets allow one party to buy and sell items directly with a counterparty, without a central exchange. A central party may facilitate market making on an OTC platform but is not involved in any executed trade. An OTC contract is a bilateral contract in which the two parties agree on how a particular trade or agreement is to be settled in the future. The FX market is one example of an OTC market. Spot, forwards and swaps are examples of OTC contracts.
On the other hand, exchange-traded contracts are standardized by the exchanges where they trade and the clearing houses at which they settle. A clearing house is a financial services company that provides clearing and settlement services for financial transactions on an exchange. The contract sets out the asset that is to be bought or sold, and how, when, where and in what quantity it is to be delivered. One example of a standardized contract traded on an exchange and cleared at a clearing house is a futures contract. A futures contract is a contract to buy or sell a standardized quantity of a specified commodity of standardized quality at a certain date in the future. The future date is called the delivery date. The commodity is, in many cases, a non-traditional commodity, such as FX or other financial instruments. For financial instruments, the delivery date is often referred to as the maturity date or value date. The time to the delivery date or maturity date is known as the tenor of the contract.
There are a number of differences between an OTC market and an exchange-based market. OTC markets require that the counterparties accept each other's creditworthiness, whereas exchange based markets are generally centrally cleared and settled via an associated clearing house; the clearing firm acts as a counterparty and hence reduces credit risk for the counterparties. OTC markets allow non-standard contracts to be traded, assuming a selling counterparty can find a buying counterparty, and vice-versa, whereas an exchange allows only certain standardized contracts to be traded. Depending on market conditions, at any given time, there may be more liquidity in either the OTC market or the exchange-based market.
Because contracts-based clearing houses, such as clearing houses associated with futures exchanges, are already well established, and provide a number of advantages, it has previously been appreciated that integrating OTC-traded contracts into a contracts-based clearing regime may be desirable. Such integration may allow a trader to benefit from the execution advantages of the OTC market and the clearing and settling advantages of an exchange.
One example from the prior art, of such integration of an OTC product into a contracts-based clearing house is in the field of submitting OTC products into a futures clearing house for settlement. Traditionally, this has been done either by defining a futures contract for every business day that the OTC contract may be settled, or by restricting OTC submission to contract dates supported by the clearing house.
FX spot comprises buying one currency and selling a different currency for immediate, rather than future, delivery. The standard settlement timeframe for FX spot trades is S=T+2 business days, where S is the spot date and T is the date of trade execution, although settlement timeframes of T, and T+1 are also possible. An FX transaction which has a settlement date after the spot date is called an FX forwards contract. In the case of integrating FX OTC positions into a futures clearing regime, to include FX spot and FX forwards, this will mean defining a new futures contract for every currency-pair and business day over the next 3 to 5 years. This obviously requires a great deal of processing and storage, as well as daily maintenance to keep pace with the change of calendar dates.
There is therefore a need to provide an improved method and system for integrating OTC trades into a contracts-based clearing house.